Working papers results

In a model with bankruptcy costs and segmented deposit and equity markets, we endogenize the choice of bank and firm capital structure and the cost of equity and deposit finance. Despite risk neutrality, equity capital is more costly than deposits. When banks directly finance risky investments, they hold positive capital and diversify. When they make risky loans to firms, banks trade off the high cost of equity with the diversification benefits from a lower bankruptcy probability. When bankruptcy costs are high, banks use no capital and only lend to one sector. When these are low, banks hold capital and diversify.

This paper is structured in three parts. The first part outlines the methodological steps, involving both theoretical and empirical work, for assessing whether an observed allocation of esources across countries is efficient. The second part applies the methodology to the long-run allocation of capital and consumption in a large cross section of countries. We find that countries that grow faster in the long run also tend to save more both domestically and internationally. These facts suggest that either the long-run allocation of resources across countries is inefficient, or that there is a systematic relation between fast growth and preference for delayed consumption. The third part applies the methodology to the allocation of resources across developed countries at the business cycle frequency. Here we discuss how evidence on international quantity comovement, exchange rates, asset prices, and international portfolio holdings can be used to assess efficiency. Overall, quantities and portfolios appear consistent with efficiency, while evidence from prices is difficult to interpret using standard models. The welfare costs associated with an inefficient allocation of resources over the business cycle can be significant if shocks to relative country permanent income are large. In those cases partial financial liberalization can lower welfare.

This paper characterizes when joint financing of two projects through debt increases expected default costs, contrary to conventional wisdom. Separate financing dominates joint financing when risk-contamination losses (associated to the contagious default of a well-performing project that is dragged down by a poorly-performing project) outweigh standard coinsurance gains. Separate financing becomes more attractive than joint financing when the fraction of returns lost under default increases and when projects have lower mean returns, higher variability, more positive correlation, and more negative skewness. These predictions are broadly consistent with existing evidence on conglomerate mergers, spin-offs, project finance, and securitization.

This paper formulates a general theory of how political unrest influences public policy. Political unrest is motivated by emotions. Individuals engage in protests if they are aggrieved and feel that they have been treated unfairly. This reaction is predictable because individuals have a con sistent view of what is fair. This framework yields novel insights about the sources of political influence of different groups in society. Even if the government is benevolent and all groups have access to the same technology for political participation, equilibrium policy can be distorted. Individuals form their view of what is fair taking into account the current state of the world. If fewer aggregate resources are available, individuals accept a lower level of welfare. This resignation effect in turn induces a benevolent government to procrastinate unpleasant policy choices.

This paper tests the broadly adopted assumption that people apply a single discount rate to the utility from different sources of consumption. Using unique data from two surveys conducted in rural Uganda including both hypothetical and real choices over different goods, the paper elicits time preferences from approximately 2,400 subjects. The data reject the null of equal discount rates across goods under a number of different modeling assumptions. These results have important theoretical and policy implications. For instance, they provide support for the idea that time-inconsistent behaviors and a corresponding demand for commitment can be observed even if individuals do not exhibit horizon-specific discounting. In addition, good-specific discounting, under certain conditions, can explain the persistence of poverty and low savings by the poor. The paper presents evidence that these conditions are satisfied in the context under study by showing that the share of expenditures on those goods with higher discount rates is decreasing with income.

In one-good international macro models with nondiversifiable labor income risk, country portfolios are heavily biased toward foreign assets. The fact that the opposite pattern of diversification is observed empirically constitutes the international diversification puzzle. This paper embeds a portfolio choice decision in a two-country, two-good version of the stochastic growth model. In this environment, which is a workhorse for international business cycle research, equilibrium country portfolios can be characterized in closed form. Portfolios are biased toward domestic assets, as in the data. Home bias arises because endogenous international relative price
uctuations make domestic assets a good hedge against labor income risk. Evidence from developed economies in recent years is qualitatively and quantitatively consistent with the mechanisms highlighted by the theory.

This paper addresses the following questions. Is there evidence of contagion in the Eurozone? To what extent do sovereign risk and the vulnerability to contagion depend on fundamentals as opposed to a country's 'credibility'? We look at the empirical evidence on EU sovereigns CDS spreads and estimate an econometric model where the crucial role is played by time varying parameters. We model CDS spread changes at country level as reecting three different factors: a Global sovereign risk factor, a European sovereign risk factor and a Financial intermediaries risk factor. Our main ndings are as follows. First, while the US subprime crisis affects all European sovereign risks, the Greek crisis is largely a matter concerning the Euro Zone. Second, differences in vulnerability to contagion in the Eurozone are remarkable: after the Greek crisis the core Eurozone members become less vulnerable to EUZ contagion, possibly due to a safe-heaven effect, while peripheric countries become more vulnerable. Third, market fundamentals go a long way in explaining these differences: they jointly explain between 54 and 80% of the cross-country variation in idiosyncratic risks and in the vulnerability to contagion, largely supporting the 'wake-up calls' hypothesis suggesting that market participats bocome more wary of market fundamentals during finacial crises.

We consider the problem of selling a firm to a single buyer. The magnitude of the post-sale cash flow rights (v) as well as the benefits of control (b) are the buyer's private information. In contrast to research that assumes the private information of the buyer is one-dimensional, the optimal mechanism is a menu of tuples of cashequity mixtures. We provide sufficient conditions on the joint distribution of v and b such that the optimal mechanism takes one of the following forms: i) a take-it or leave-it offer for the smallest fraction of the company that facilitates the transfer of control, or ii) a take-it or leave-it offer for all the shares of the company. We also identify a sufficient condition for the seller to extract the full value, v, per share so that the buyer earns information rents only on the private benefits of control.